Tracy Basinger on Shifting the Regulator Mindset to Encourage Inclusive Innovation

This is Pacific Exchanges, a podcast from the Federal Reserve Bank of San Francisco. I’m Cindy Li.

And I’m Sean Creehan. Welcome back to Financial Inclusion & Beyond, an ongoing exploration of what we can learn from efforts around the world to improve financial inclusion and wellbeing. In today’s episode, we sat down with Tracy Basinger, the recently retired head of supervision here at the San Francisco Fed.

Tracy has spent her career focused on the impact of financial services on everyday citizens. From leading consumer protection here at the San Francisco Fed to overseeing a nationwide team considering policy solutions for small businesses suffering during the COVID-19 crisis, Tracy has thought long and hard about the role of public policy, regulation, and technology in promoting a more inclusive financial system.

I do think 2020 provides us an opportunity to take a step back and really look at all of our rules and our supervisory policies from an inclusion lens, and ask ourselves, “what impact is this rule or is this guidance having with regard to inclusion, and do we need to re-think it at all?” I think that would be a really important thing for the agencies to do moving forward.

We get into examples of financial innovations that are promoting inclusion and the challenges for regulators and policymakers who want to minimize risks to consumers and the broader financial system while not getting in the way of positive change. And we talk about how to shift from a historical mindset that focused on preventing exclusion to one that thinks about ways to promote inclusion and broader notions of financial health and wellbeing.

We’re glad we got to hear Tracy’s reflections as she steps away from a long career at the Fed. Clearly there’s a lot of work to do! Let’s get to the conversation!

Tracy, thanks so much for joining us today.

Happy to be here.

So we started to develop this podcast series prior to the pandemic, but this past year’s unique circumstance have forced us to look at financial inclusion from new angles. Can you share some takeaways from our work at the Fed this past year, especially the Main Street Lending Program, that can shed light on the current status of financial inclusion in our economy?

Sure. Our work on Main Street was specifically to look at the needs of small businesses, because Main Street was originally designed for sort of middle market businesses, and we were looking to see if we could adjust it to really get at the small businesses and to consider ways to allow non-bank lenders to be able to participate in the programs such as small CDFIs or fintech lenders, given their record of being able to serve small businesses.

And I think we saw through the work we did on that program and all the information that we were able to gather as well as what we learned from the PPP program and our PPPLF, confirmed that small businesses, in particular, have a much more challenging time accessing credit and certainly accessing credit from the banking system itself, that they tend to use alternative means. And so we learned, I think, a lot and maybe even confirmed some of what we had known before about the need to think differently about how we would want to serve small businesses and the best ways to reach them.

For the benefit of the audience, the PPP that you’re mentioning stands for the Paycheck Protection Program, which was an emergency lending program for small businesses that was part of the initial CARES Act stimulus and run by the Small Business Administration and Treasury Department. The Fed helped support that program by providing liquidity to participating financial institutions through what we call the PPP Liquidity Facility, or PPPLF. And we saw a number of stakeholders flex there as non-banks found ways to participate and access Fed liquidity through correspondent banks. Tracy, beyond that work for small businesses, were there any other high-level takeaways on what we learned from the crisis in terms of the state of financial inclusion in the United States?

I think, what we saw in 2020 was the COVID event accelerated the use of digital services. Right? And I’ve long held the view that appropriately developed technology can really help move the needle on financial inclusion. And when we saw the adoption of digital services, contactless payments, new types of online tools, you see that it really does make a difference and the COVID event is the forcing event that caused us to accelerate the adoption.

And by all accounts, it looks like that we’re going to continue to accelerate adoption. So from my standpoint, it’s going to be intriguing to see if this accelerated adoption really does help start moving the needle on financial inclusion and then it raises the question of how do the banking regulators engage here in ways that help move the needle forward in a responsible way.

So, Tracy, just reflecting upon these observations and your work throughout the year, what are some of the roles, in your view, that financial regulation and supervision can play to improve inclusion, and maybe financial health, in general?

Yeah, that’s a great question. I think that, based on my experience of what I’ve seen, the number one thing that, even before we had fintech, and technology was really changing financial services, clarity on the regulations, I think, is huge. When lenders or service providers are not clear how the regulators are going to respond to certain products or services or terms or conditions, and they’re afraid of the potential repercussions, then they tend not to lean in and engage.

So I think clarity around the rules. What applies. What doesn’t. What kinds of actions that would be the consequences if something goes wrong. I think engaging with whoever the service provider is as they’re trying to bring a new product to market so that we can not only learn how they’re doing it and what they’re hoping to accomplish, and then you can be guiding, from a regulatory and supervisory standpoint, along the way, so that you don’t have to come in on the backend after something bad has happened.

It’s similar to the concept of a regulatory sandbox, but it’s not that you’re testing the product, but it’s just that you’re helping advise entities as they’re looking to develop new products and services. To me, those are really big ways that I think we can make a difference that just by providing clarity and engaging differently. But I do think 2020 provides us an opportunity to take a step back and really look at all of our rules and our supervisory policies, from an inclusion lens, and ask ourselves, “What impact is this rule or this guidance having with regard to inclusion and do we need to rethink it at all?” I think that would be a really important thing for the agencies to do going forward.

One of the challenges there, Tracy, just hearing you talk a lot about the existing rules and the frameworks that we have, and of course, regulators and policy makers, that’s kind of the way they think. Right? You can do this and you can’t do that. Is there an inherent challenge in rules-based systems for promoting that maybe unknown innovation that’s bringing in more people and positively changing—how do you view that trade-off between thinking about the benefits and promoting something positive versus saying, “Don’t do this risky thing.” It seems like a tough challenge particularly in a space like this where sometimes bringing people in may create new risks.

Yeah. I think that’s the key point there, right, Sean, is that historically regulators are considered successful if they help prevent bad things from happening and aren’t as much charged with making good things happen. And I think that’s the paradigm shift here is to think about not only how do we protect consumers from having bad things happen to them, but if our goal is also to have more individuals, more consumers, that can participate in the financial system, then I think you look at the rules from a different standpoint.

And that, to me, would be what I would mean when I say, “Take a look at all of our rules through an inclusion lens.” It’s, if that’s our mandate, what are the things that we have to do from a supervisory standpoint to actually promote that as opposed to simply preventing bad things from happening when services are put in the marketplace.

Tracy, you just touched upon some of the potential benefits associated with disruption brought by fintech firms, or fintech industry, for the banking sector. I think, under your leadership, the San Francisco Fed has also done a lot of work trying to promote better understanding of the fintech industry among financial regulators. Where are we in terms of regulators understanding all fintech developments and why is this important?

While I think we’ve made progress, I think we have a ways to go. I think that the United States, in particular, hasn’t leaned in as much as perhaps other jurisdictions in the world. And because of that, as a general proposition, we’re not supervising these firms. We’re not engaging with them in ways that could help guide the development and could help accelerate our learning as quickly as maybe other jurisdictions. So I’m encouraged to see that more and more regulators are starting to lean in. And I think we all need to lean in, to engage much more proactively and to shape these developments for the sort of positive outcomes that we’re all hoping for.

I guess, if we are thinking about some of these positive outcomes. Financial inclusion, going back to that topic, is one of the greatest potential benefits that policy makers want to see from a more prosperous fintech industry per se. So what are some of the changes you wish to see to improve financial services sectors’ effective commitment to financial inclusion? maybe you can share with us how you see fintech industry moving the needle and disrupting some of the balance.

It’s how technology is used that I think is what makes a difference. What you see in a lot of the business models from the new fintech firms, or even existing entities that are trying to offer digital products, is a movement away from a banking industry where there was a standard product, and everybody got the same product, to a product that is customizable for each individual’s need, that sort of meets them where they are and understands that different people deal with financial services differently.

And so I think that’s the biggest opportunity here is customizable products that meet people where they are and that don’t have to be one size fits all for everybody. And I think from the startup standpoint, there’s more of an understanding of where people are than perhaps has been as evident in the banking system in the past, and that, to me, is the big change we’re seeing.

So interesting just thinking about that meeting people where they are and human-centric design principles, which we talked about actually earlier in this series. And obviously, there are a lot of potential gains for people’s financial health if they have an app that’s helping them save a little bit more or find a better rate, maybe nudging them to get some insurance or whatever it may be. But, of course, there’s downsides. Right?

I mean, not every lender is always going to be thinking about their customer’s interest. They may be just be trying to get a short-term profit. And so I wonder how you think about that challenge moving forward. If you imagine a future where everyone has a robo financial advisor that helps them manage a lot of different parts of their lives, do you worry about that and does it imply that regulators need to have a view of what it actually means to be financially healthy?

I think that’s the biggest thing to worry about and I think about it on several different fronts. One is that, when you introduce technology this way, you can cause harm at scale, in a hurry, in a way that perhaps in a previous era you couldn’t. You couldn’t cause that much harm to that much scale. So you do need to be mindful of that. I think that the other aspect here is that we have an imperfect financial system now and we tend to think about new products in isolation or new services in isolation. Like, are they in and of themselves completely perfect versus are they better than perhaps incrementally where we are today?

And that is where I think regulators have an opportunity to sort of ask that question, “How do we think about whether or not what we’re seeing is an incremental gain from where we are? It might not be perfect, but it’s an incremental gain, so we can take that incremental gain and then build on that for another incremental gain in terms of this idea of inclusion and fairness.” Because I subscribe to the idea that we’ve got, and I think 2020 showed us this abundantly, that our financial system is not fair today. Choosing today’s over something that’s incrementally better, but not perfect… that’s not ever going to move the needle at all…. and that’s really challenging. It’s easy to say, but that is a really hard thing for regulators to do, but I think that mindset is how we need to be thinking about things going forward.

Tracy, let’s talking a little bit more about the shifting of the regulator mindset. The role of banking supervision is clearly evolving over time. How do we make supervision more effective and more forward looking?

There has to be a shift in the mindset away from simply preventing bad things from happening, but causing good things to happen. And that’s a pretty big change. That would also likely require some regulatory change, but we could help inform what would be the right kind of regulatory change there.

I also think that the types of relationships, how you engage with supervised entities, matters. Early on in my career somebody said to me that their philosophy on supervision was the right amount of supervision is the least amount of supervision necessary to get to a good outcome. And that has always stuck with me because that allows you to have a different kind of relationship with the regulated entity. If we’ve got that common understanding and common goal of what we’re going to do and how we’re going to react to things that come up along the way. And so that, I think, is a mindset shift from supervision that could be helpful in this kind of environment with that kind of mandate to improve financial inclusion.

As a senior regulator, you are constantly thinking about what is really that right balance between risk and benefit in terms of our regulatory and supervisory philosophy. So thinking about consumer protections and financial stability, what are some of the potential cost or risk that fintech industry could bring or introduce to the financial services industry that we should really pay attention to?

That’s, I think, a really great question because that’s the whole issue with services being outside of the banking industry, outside of the so-called regulatory perimeter, so they’re not being regulated or supervised the same way as they are in the banking system, and often there isn’t as good of a picture into where the risks are. So that, to me, is the big risk because you don’t have as good of a view into where the risks might be. You don’t have access to the same kind of data. You aren’t able to, in a real-time basis, see how the industry is evolving.

So, to my mind, that is why I’ve always been an advocate of really considering where and how firms are regulated. It’s like, if they’re engaging in financial services, I think asking ourselves the question of what’s the appropriate way to regulate them from a financial stability standpoint and from a consumer protection standpoint. Now there’s various different regulatory agencies, in both federal and state, you can accomplish that a lot of different ways, but making sure that there’s some sort of consistency or evenness in the level of supervision, I think, is what’s really important there from a overall sort of macro consumer protection and financial stability standpoint.

So sitting here at the Fed, or in our recording closets at our houses here during the pandemic, but sitting here and thinking about the vast powers of a central bank, powers that in some ways have expanded over time and not without controversy. Even with the Main Street Lending Program, we saw a lot of consternation in Congress about how much the Fed shouldn’t be doing some of these programs. But just putting that to the side and thinking beyond our scope as a central bank, are there any other things that you think could really help, from a fiscal perspective, from other parts of the government, that would improve financial inclusion?

So for example, I’m thinking, the Paycheck Protection Program. That was a Small Business Administration, Treasury run, program. We helped provide some liquidity on the side, which was very, very important, but are there certain things that you’ve seen in your 30 plus years as a regulator where you wish other parts of the public sector would lean in a little bit more?

That’s a great question. As I think about that, I have to believe that the lessons of 2020 are going to be really informative here. You mentioned the Paycheck Protection Program. We’re going to learn a lot from that as to how can we better serve small businesses. Not the grant part of the program itself, but necessarily the kinds of lenders that got engaged. How they were able to reach small businesses. Why they were better able to reach certain communities that bankers were not able to reach.

So I think that’s going to be instructive as to how you need to engage differently and which parts of government, if you will, are better suited to engage. So, that, I guess, is my initial thought when you asked that question is that, I think we’re going to learn a lot from what happened last year, but I also think there was pretty broad recognition that we need to be thinking bigger than just the banking industry when it comes to financial services in terms of reaching underserved communities and underserved individuals.

I guess, as you step down from your position as the Head of Supervision here at the San Francisco Fed and reflect back on your career and look forward, whether it’s from the perspective of private sector innovation or regulation, are there things that you dream about or hope to see over the next decade or two that haven’t happened yet?

We have tremendous opportunity to make strides that we didn’t have just a year ago to really make a difference. The events of 2020, collectively, not just COVID, but the civil unrest, everything that happened last year has exposed the depth of the problem in a way that I think there’s more people in this country that are willing to say, “We’ve got to do something to address this issue.”

So I think, collectively, as you see people come together that you’re just going to bring to bear more ideas and more opportunities to improve what we had started in terms of leveraging … I’ll just speak narrowly in financial services, leveraging technology for financial inclusion purposes. And so, to me, what would be really exciting to see is that the momentum continues there and that we actually pick up the pace as opposed to sort of revert back to how things were pre pandemic.

So 20 years from now, everyone who wants to have some sort of credit score history, maybe they get one, even if they have a limited financial history, they’ve done something, they’ve paid rent. Or the idea that everyone in a pandemic should be able to receive a government stimulus payment that they, by the letter of the law, were entitled to, and to receive that immediately without uncertainty and stress, and just a lot of hoops to jump through. We would hope we can solve those problems. Right? I mean, that’s kind of where my mind is on this issue.

Yeah. Absolutely. I think the strides we’re making to address the income and expense mismatch for low income people in particular, rethinking the whole concept of when you get paid, how you get paid, can make a huge difference and, to my mind, as we advance in the payment space, there’s not the same kind of cost associated with making more frequent payments.

So we have so many opportunities to do the, not only what you suggested, Sean, which is to get people, access to things like stimulus checks, but get them access to their pay on a sort of more frequent or real-time basis so that we don’t have to suffer through that income and expense mismatches.

Yeah. That’s a super interesting topic. I wonder, as well, if we make advances there, if we might actually make some of the existing liquidity solutions, financial solutions, almost unnecessary too, because if you’re working at Walmart and you’re getting paid every day for the work that you do, maybe you just don’t even need that short-term credit to get you through to the next expense. Right?

So it’s interesting like, to the extent the payment system improves in that way, maybe other parts of the financial system, there’s not as much need for it.

Exactly.

Which I guess for those lenders, it’s not good news, but for that individual and everyone else, it’s certainly good news.

Yeah. Well, and then the industry evolves and there’s different ways in which the service providers are able to make a reasonable profit for the service that they’re providing.

Yeah. I’m thinking about fintech service providers. They are successful because they provide a solution to a specific problem that exists the financial services’ industry. And the other is a part of it is throughout 2020, I think, we are seeing traditional banks also upping their technology game, upgrading their infrastructure. So I feel that probably will reshape some other conversation in the years to come.

Yeah, I think you’re right, Cindy. And I think that we’ve long talked about having a digital strategy. Having a strategy with regard to technology was a key risk in banking given how customer preferences are changing. I think that that risk is accelerating because it doesn’t look like we’re going to go back to sort of business as usual going forward. That the, in some ways, a big chunk of the brick and mortar branch banking is in question now. And so I think it is going to fundamentally change. And then that’s going to not only introduce new risks, but new opportunities.

I mean, Sean, you were referring to some of the fees that would be lost if we get to a sort of a real-time payment space. I remember a day in banking when customers were discouraged from overdrawing their account and the fee was meant to be a penalty so that you didn’t bounce a check, so to speak. And then it evolved into an opportunity to encourage people to use that as a tool to manage their sort of short-term liquidity needs. And so things continue to evolve and I’m sure that it’ll be really interesting to see what new risks and what new opportunities come out of this particular evolution.

Yeah. I was just reading an article about the next stimulus payment and for people that have overdrawn their accounts with a bank, how that works. Will the bank, where they’re associated with, that’s where they get their stimulus check, will they keep that money or will they give it on to that consumer? I mean, will they charge a fee? All of these questions are big ones and some of them are beyond the scope of the Fed, but it’s important for us to promote conversation around them because it all matters a lot.

Connected to a lot of what we’ve already discussed, for a long time, when regulators and policy makers talk about innovation, we’ve just used the phrase, “We want responsible innovation” and that’s what we’re here for. To promote responsibility. On our team and here at the San Francisco Fed now looking at fintech, we’re broadening our concept of that, so you’re not just responsible, but inclusive innovation. And this gets back to the tensions that we talked about earlier. But if you were to tie it up in a bow, to the extent you can or really think about, what does that mean to you to say it’s both responsible and inclusive? Maybe our responsibility is to be inclusive. Like I don’t want to wordsmith too much, but what do you think that phrase means?

It’ll be interesting, Sean, to see if, as we move forward, if the term responsible innovation gets used the same way it has in the past. I think historically we’ve referred to that as something that is not causing harm to consumers and that that was the intent behind it. And I think that if I were to think about it today, it would have to be much broader than that. Right? It would have to include the idea that it also is inclusive. That it is reaching a broad set of customers.

And you think of some of the business models that you have heard or products you’ve heard about where it was responsible in the sense that it wasn’t causing harm, but it was available maybe only on Apple devices. So it would be exclusive in terms of only people who have Apple devices could download the app. That’s not inclusive. And so, to my mind, inclusive is the broader term. Inclusive implies that you’re not doing harm. So I would almost argue, going forward, that the word inclusive should replace responsible innovation and that would cause us to about it more broadly.

Well, I just wanted to thank you again for joining us today and thank you for all that you’ve done, your leadership and vision and service at the Federal Reserve for the last three plus decades. From all of your working consumer compliance to the latest leadership around the small business lending and Main Street, it’s been an honor and a privilege to work with you, and really excited to get your perspective as we wrap up this podcast series on inclusion and financial health.

Great. Well, thank you, Sean, and thank you, Cindy. It was fun being here today, and I’m a big fan of the work that you all are doing, so looking forward to the whole series.

We hope you enjoyed today’s conversation with Tracy. It’s humbling to think that policy makers and regulators have been thinking about these challenges for so long with some real accomplishments, but yet so much work remains.

That’s right. It’s actually exciting time to think about the dynamic among technology, financial services, and regulation, as well as inclusion as a policy goal.

For more episodes like this, you can find us on iTunes, Google Play, Stitcher, and Spotify. And if you like what you hear, please leave a review—feedback from listeners like you will help more people find us. And for even more content, look up our Pacific Exchange Blog, available at FRBSF.org. Thanks for joining us.